Home Depot’s Stock Drop is a Case of Irrational Pessimism

Back in the early dot-com boom, Alan Greenspan, the Federal Reserve Board Chairman at the time, coined the phrase “irrational exuberance”. This describes the kind of mania that can overtake investors when they continue to bid up stock and lose sight of the stock’s real value.

The opposite can also be true. Rather than be exuberant, investors can follow the crowd on bad news. That can lead to a stock falling more than what is justified. I’ll call this scenario “irrational pessimism”. And that is what I believe is going on with Home Depot.

Home Depot’s stock is down over 5%

Home Depot NYSE: HD shares took a sharp decline as the stock reported mixed third-quarter results. On the earnings front, the company reported net income of $2.8 billion or $2.53 per share. This came roughly in-line with the results from the same quarter in 2018. At that time the company reported an EPS of $2.51 on net income of $2.9 billion.

Analysts were expecting a slightly lower EPS of $2.52 per share. However, the revenue came in slightly less than the consensus expectation of $2.75 billion. The company also reported a lowered forecast for full-year sales. The company is now expecting full-year sales to rise approximately 1.8% which includes 3.5% comparable sales growth. This is down from a previous estimate for 2.3% full-year sales growth with a 4% growth in comparable sales.

Home Depot Chairman and CEO Crag Menear offered this assessment, “Our third-quarter results reflected broad-based growth across our business, yet sales were below our expectations driven by the timing of certain benefits associated with our One Home Depot strategic initiatives,” said Menear. “We are largely on track with these investments and have seen positive results, but some of the benefits anticipated for fiscal 2019 will take longer to realize than our initial assumptions.”

What’s really bothering investors

As of this writing, HD shares are down over 5%. In my opinion, there are two catalysts for this drop. The first is an over-reaction to larger macro-economic events. The U.S.-China trade war still hangs like a sword of Damocles over the market. And that’s the real story behind the Home Depot stock drop. All the major indexes were down at midday. The pullback falls squarely on the news that Chinese authorities are now pessimistic about the two countries coming to an agreement on rolling back (or not rolling back) tariffs.

And the second is simple profit-taking. Investors often trade on emotion and justify with fact. Earnings reports can give investors a reason to do what they want to do anyway.

Is Lowe’s a threat?

Some analysts also have the belief that customers are warming back up to Lowe’s NYSE: LOW. At least one analyst is expressing that the playing field between the two home improvement superstores may be leveling. “… the visibility of Lowe’s has been improving and we believe that growth in the market is now being more evenly shared between the two main players,” wrote Neil Saunders, GlobalData managing director. However, Saunders conceded that there has not been a major erosion in Home Depot’s market share.

Lowe’s stock was also down on Tuesday. Lowe’s will be reporting earnings after the bell on Wednesday.

The housing market remains bullish for Home Depot

One of the catalysts for Home Depot stock is the housing market. With the Federal Reserve lowering interest rates, mortgage rates are approximately 100 basis points lower from this time in 2018. Existing home sales also remain positive.

And HD stock also should get a boost from the Commerce Department that released housing starts data on Tuesday that showed U.S. homebuilding rebounded in October. Permits for future home construction also increased and are now at their highest level in 12 years.

“This is an important report for future homebuyers since one of the largest deterrents to entering the market right now is the lack of robust housing options,” said Bill Banfield, executive vice president of Capital Markets at Quicken Loans in Detroit.

Raymond James analyst Matthew McClintock said, “With the company prudently reducing Q4 2019 expectations and assuming no improvement in the two-year stacked comp (despite an improving macro), we view Q4 as largely derisked,” remarked McClintock. “We believe Home Depot should be bought on weakness.”

What’s next for Home Depot?

Home Depot has been investing in creating an omnichannel experience that is keeping Amazon NASDAQ: AMZN from making a full plunge into the home improvement market. The opportunity for consumers to order online and have their local store deliver items to their home is creating a more curated experience that consumers expect.

However, competing with Amazon requires an investment. And that investment means short-term pain for long-term gain. Weakness in the housing sector would become a reason to sour on the stock, but that does not appear to be a near-term concern. And while Lowe’s may be more aggressive, Home Depot has consistently scored high in brand loyalty and continues to do so with its investment in digital technology.

In short, I think investors will find today’s dip much ado about nothing when it comes to Home Depot. Investors were looking for an excuse to take profits and they got one.